This specialist fund manager has bottomed out

Today, those who bought Polar shares at those levels will be sitting on some hefty paper losses. However, the company has recently shown enough signs of stability in both market focus and fund flows to suggest that a bottom might be in the stock. If Polar can deliver improved investment performance, particularly from higher valuations for healthcare tech companies, then the possibility of staging a re-rating in profits or the shares’ earnings multiple starts to look more plausible. In this scenario, returning to the long-term average would imply a profitable gain for investors.

Mean reversion may not be an exciting enough a prospect for investors to buy into Polar’s story. It’s certainly less exciting than the themes the group’s fund managers focus on. But because the two dynamics are interlinked, it is worth looking at Polar’s fund product mix to assess whether better valuations in some of its core areas of focus can start to push up earnings. Spoiler: we think they can.

Recovering healthcare

The tremendous recovery in pharmaceutical shares, led by companies specialising in oncology, diabetes and weight-loss drugs, is a fair indicator for the rest of the healthcare sector. When times are good for pharmaceutical companies, pharma capital tends to find its way into niches in the rest of the healthcare universe. Currently, valuations in the world’s most dominant and lucrative market do not appear too stretched: iShares’ popular US Pharma ETF (US:IHE), a market-cap-weighted index tracker of the largest US names in the sector, is priced at 17 times forward earnings, and at a level to stimulate price-conscious investor interest.

Valuations are improving, though, which is good news for Polar’s health focus. For instance, medical technology and healthcare companies have seen a trend towards higher valuations lately, after experiencing prolonged weakness through the second half of 2021 and into 2022. Industry newsletter HealthTech M&A notes that take-out valuations have seen a discernible recovery on several metrics. In 2022 and the first quarter of this year, the average enterprise value (EV) of acquired firms was 5.6 times sales, compared with the 3.6 seen in 2021. The same trend is reflected in EV to cash profit multiples, which at an average of 12.5 is also up on 2021. If we consider merger and acquisition (M&A) valuations as a lead indicator, then Polar’s investment position and performance for several of its key strategies should start to show better returns by the time of the next results in October.

In fact, its latest trading update already showed that the outflows that unbalanced the group’s assets under management (AuM) have started to moderate. Net outflows of £201mn for the June-end quarter were a marked improvement on the £410mn seen three months earlier. Management noted that its Biotech, Healthcare Blue Chip and Smart Energy funds were still seeing interest from investors, while net redemptions from technology open-ended funds halved from £199mn to £103mn. Of course, outflows are still outflows, and will impact negatively on fees, but equities no longer appear to be the asset class to avoid. Figures from the Investment Association suggest net inflows to UK-wide open-ended funds swung to £1bn in July, from a £1bn outflow in the prior month.

The fact that market performance has held up, offsetting any outflows, helps explain why analyst forecasts for earnings across 2023 and 2024 have remained level throughout this year. This is despite sharp downward revisions for specialist asset manager peers Liontrust (LIO) and Impax (IPX), as the chart below shows.

This is important, as Polar’s highly concentrated investment strategies can generate operational gearing even if there is only a marginal underlying recovery in AuM. Although other specialist fund managers have a similar business model, the difference is Polar is still invested in sectors and themes whose reputations, if not always their valuations, are broadly intact. By contrast, it remains to be seen whether ESG investing can recover its credibility as the toll from dubious investing promises, incoherent rating systems and overhyped marketing continues to chip at the strategy’s image. And while the group’s ‘sustainable thematic’ range of funds has the largest AuM growth capacity of any fund line, Polar’s light holdings in this field suggest it has a lot less to lose than Impax or Liontrust.

Market negatives

The downside to Polar’s investment case reflects the broader problems with the asset management sector. The company flies the flag for active fund management, and its associated fees, at a time when the inexpensive competition offered by simple tracker funds and passive investing has come to dominate the funds market. In an era when technology companies occupy an ever-larger share of the MSCI World and the S&P 500 indices, the job of an active manager searching for alpha becomes even more difficult.

In the long term, this poses a risk to Polar’s growth, as continued asset gathering tends to risk the mix of instability, inertia and underperformance that characterises so many sector giants. From that point of view, Polar will always be a niche play, both in its investment style and how it is viewed by investors. 

The other negative is interest rates, which have a dampening effect on all equities, although perhaps especially those corners of the market where valuations tend to get carried away. The flipside to this situation is that Polar will be earning better returns from its considerable cash holdings (which at last count stood at £107mn) and investment income without trying too hard.  

Where it has branched out into partnerships, the results have not been successful. The best thing that can be said about the long-running saga over boutique Phaeacian Partners, a joint venture Polar launched in 2020 along with two principals from Los Angeles-based peer firm First Pacific Advisors (FPA), is that the fallout hasn’t been worse. Polar pulled out of the venture a year ago, resulting in a protracted legal battle with FPA, which now appears to be reaching a settlement agreement.

Valuation

Pessimistic sentiment has resulted in a valuation that on several measures makes Polar shares cheap. On a headline basis, they trade at 12.5 times Numis earnings forecast for 2024, although strip out the group’s large (and income-generating) cash pile, and this falls to less than 10. Fundamentally, with the worst performance for UK asset managers in 2022 now discounted in shares across the sector, the downside seems to have already been baked into current valuations.

If Polar demonstrates enough resilience in the coming quarters, then a partial re-rating to match the sector average price/earnings (PE) multiple of 15 is a realistic possibility. Should signs of operational gearing emerge, then the chances of Polar returning to a premium to the sector are also better than evens. In the meantime, patient investors can make do with a dividend yielding an inflation-beating 9.5 per cent for 2024, which should be covered by free cash flow if the group hits its earnings forecasts.

The benefit of investing in Polar’s shares, as opposed to its funds, is that it gives exposure to the proxy performance of the company’s investment strategies, minus the fees that tend to chip away at returns. Momentum in asset gathering is returning. Now feels like time to call the bottom and await a better period for returns.